Through Growth, Crowdfunding Continues Its Search For Identity

The impending passage of the JOBS Act has highlighted many practical implementation challenges. What can crowdfunding be used for? Who benefits? How does it work? Competing - sometimes conflicting - crowdfunding models not only deliver different benefits, but also have different challenges. The stakes are high: as the space becomes more defined, and standards more firmly established, the opportunity for disruption is massive.

Fundraisers: Realizing Ideas vs. Building Businesses

Most traditionally venture-backed entrepreneurs that use crowdfunding are only using it for a portion of their round (say, 20%) as vs. the whole round. Slava Rubin (IndieGoGo) adds color to this by noting that money isn't the primary reason to use a crowdfunding platform: "When you do a crowdfunding campaign, you get to gauge demand, test marketing and iterate cheaply, gain exposure you couldn't otherwise, and obtain data. Campaigns take you from a transaction to a relationship. People will pay margin to build ongoing relationships."

Dawn Lepore (Prosper) noted that entrepreneurs (the everyday, non venture-backed kind) make up a substantial portion of Prosper's users. For them, Prosper is an alternative to banks - the average Prosper user receives funds within six days of filling out an application.

Independent creators, on the other hand, may funnel their entire fundraising effort through a single campaign. According to Becca Plofker (Idea.me), many creators don't consider themselves entrepreneurs - they just want tools and support to bring their ideas to life.

Funders: Passionate Patrons vs. Day Traders

On one extreme, the passionate funder of an indie album doesn't expect a fiscal reward for his/her support. They're creating the change they want to see in the world (crowdfunding can be applied to public good), or enjoying being part of a cultural experience.

At the other extreme, you see equity funders, who expect a fiscal return. Equity funders not only use platforms because they deliver access to opportunities, but also because through a crowdfunding platform, the small investor can (usually) obtain the same terms that more sophisticated investors agree to. These small investors can get a taste of the high-risk, high-reward investing that existing angels take part in, or they can invest in a local mom-and-pop.

Skeptic Naval Ravikant (AngelList) puts a sharper point on small investors entering the private market: "Only 1/N angel-backed companies will make money in the private market...there will be lawsuits." That said, it remains to be seen what expectations the market will have for equity crowdfunding. As private asset marketplaces democratize fundraising beyond Silicon Valley tech companies, the "restaurant investor" model may be closest. Restaurant investors enjoy the perks of being an investor, and may be able to get some financial returns; but they also realize that not all restaurants make it, and easy liquidity (a la public markets) is not a given.

Platform Models: Transaction-Based vs. Market-Based

Both project platforms and equity platforms tend to be more transaction fee-based, but platforms that deliver equity funding must answer different structural questions than passion-based platforms do.

To what extent are crowdfunding services intermediaries, and to what extent are they marketplace platforms?

Will small investors suffer from adverse deal selection?

Is it incumbent upon the platform to put together the same leverage that more sophisticated investors have? Should they perform due diligence, cultivate access to management, and so forth?

Can you show effective visibility into exit strategies at an early stage?

Lending platforms such as Prosper make money on origination and servicing fees, while banks make money on the market-rate interest spread. Over time, banks have taken notice of peer-to-peer lenders such as Prosper and Lending Tree, but they haven't yet chosen (or perhaps, haven't yet figured out how) to enter this segment.

Though it hasn't happened at any scale yet, we can also expect these platforms to test success-based revenue models.

Regulation: Potential Pitfalls for Everyone

Slava called out that "the SEC has a tough job - they get paid to regulate, not innovate." Companies such as AngelList and Prosper solve problems by iteration, but the SEC needs to get things right on Day One. When the SEC does iterate, the cycles are measured in years, not weeks or months. This timing mismatch is a possible sore spot over the next few years, as innovators iterate ahead of what regulators anticipate.

It may be frustrating to educate regulators on model innovation, but it's part of the process. Or as Lepore puts it, "regulation is here to stay, especially when you're dealing with people's money. So you'd better have a good relationship with regulators."

Why Crowdfunding is Here to Stay

Moderator Martin Schneider (451 Research) posited today that crowdfunding isn't a zero-sum game. I tend to agree, as did the funding panel. Slava asserted that crowdfunding will double the size of the capital market. As Naval nicely put it, "the rise of social media didn't kill socializing...and AngelList augments existing investment networks in New York and San Francisco. Though outside of New York and San Francisco, we're the only game in town."

Personally, I believe in crowdfunding because it enables anyone to express their creative self - not just established nonprofits who can hire development officers to build foundation support, or "discovered" artists who have a lockdown on mainstream media distribution.

Professionally, I'm thrilled that crowdfunding levels the playing field for entrepreneurs. (As is evidenced by Intel Capital's recent investment in Funders Club.) Not everyone with an idea and passion has connections to the angel investment community. Crowdfunding disrupts traditional market inefficiencies via automated platforms - and if the history of eBay can serve as precedent, the ripple effects may be significant.

The impending passage of the JOBS Act has highlighted many practical implementation challenges. What can crowdfunding be used for? Who benefits? How does it work? Competing - sometimes conflicting - crowdfunding models not only deliver different benefits, but also have different challenges. The stakes are high: as the space becomes more defined, and standards more firmly established, the opportunity for disruption is massive.

Fundraisers: Realizing Ideas vs. Building Businesses

Most traditionally venture-backed entrepreneurs that use crowdfunding are only using it for a portion of their round (say, 20%) as vs. the whole round. Slava Rubin (IndieGoGo) adds color to this by noting that money isn't the primary reason to use a crowdfunding platform: "When you do a crowdfunding campaign, you get to gauge demand, test marketing and iterate cheaply, gain exposure you couldn't otherwise, and obtain data. Campaigns take you from a transaction to a relationship. People will pay margin to build ongoing relationships."

Dawn Lepore (Prosper) noted that entrepreneurs (the everyday, non venture-backed kind) make up a substantial portion of Prosper's users. For them, Prosper is an alternative to banks - the average Prosper user receives funds within six days of filling out an application.

Independent creators, on the other hand, may funnel their entire fundraising effort through a single campaign. According to Becca Plofker (Idea.me), many creators don't consider themselves entrepreneurs - they just want tools and support to bring their ideas to life.

Funders: Passionate Patrons vs. Day Traders

On one extreme, the passionate funder of an indie album doesn't expect a fiscal reward for his/her support. They're creating the change they want to see in the world (crowdfunding can be applied to public good), or enjoying being part of a cultural experience.

At the other extreme, you see equity funders, who expect a fiscal return. Equity funders not only use platforms because they deliver access to opportunities, but also because through a crowdfunding platform, the small investor can (usually) obtain the same terms that more sophisticated investors agree to. These small investors can get a taste of the high-risk, high-reward investing that existing angels take part in, or they can invest in a local mom-and-pop.

Skeptic Naval Ravikant (AngelList) puts a sharper point on small investors entering the private market: "Only 1/N angel-backed companies will make money in the private market...there will be lawsuits." That said, it remains to be seen what expectations the market will have for equity crowdfunding. As private asset marketplaces democratize fundraising beyond Silicon Valley tech companies, the "restaurant investor" model may be closest. Restaurant investors enjoy the perks of being an investor, and may be able to get some financial returns; but they also realize that not all restaurants make it, and easy liquidity (a la public markets) is not a given.

Platform Models: Transaction-Based vs. Market-Based

Both project platforms and equity platforms tend to be more transaction fee-based, but platforms that deliver equity funding must answer different structural questions than passion-based platforms do.

To what extent are crowdfunding services intermediaries, and to what extent are they marketplace platforms?

Will small investors suffer from adverse deal selection?

Is it incumbent upon the platform to put together the same leverage that more sophisticated investors have? Should they perform due diligence, cultivate access to management, and so forth?

Can you show effective visibility into exit strategies at an early stage?

Lending platforms such as Prosper make money on origination and servicing fees, while banks make money on the market-rate interest spread. Over time, banks have taken notice of peer-to-peer lenders such as Prosper and Lending Tree, but they haven't yet chosen (or perhaps, haven't yet figured out how) to enter this segment.

Though it hasn't happened at any scale yet, we can also expect these platforms to test success-based revenue models.

Regulation: Potential Pitfalls for Everyone

Slava called out that "the SEC has a tough job - they get paid to regulate, not innovate." Companies such as AngelList and Prosper solve problems by iteration, but the SEC needs to get things right on Day One. When the SEC does iterate, the cycles are measured in years, not weeks or months. This timing mismatch is a possible sore spot over the next few years, as innovators iterate ahead of what regulators anticipate.

It may be frustrating to educate regulators on model innovation, but it's part of the process. Or as Lepore puts it, "regulation is here to stay, especially when you're dealing with people's money. So you'd better have a good relationship with regulators."

Why Crowdfunding is Here to Stay

Moderator Martin Schneider (451 Research) posited today that crowdfunding isn't a zero-sum game. I tend to agree, as did the funding panel. Slava asserted that crowdfunding will double the size of the capital market. As Naval nicely put it, "the rise of social media didn't kill socializing...and AngelList augments existing investment networks in New York and San Francisco. Though outside of New York and San Francisco, we're the only game in town."

Personally, I believe in crowdfunding because it enables anyone to express their creative self - not just established nonprofits who can hire development officers to build foundation support, or "discovered" artists who have a lockdown on mainstream media distribution.

Professionally, I'm thrilled that crowdfunding levels the playing field for entrepreneurs. (As is evidenced by Intel Capital's recent investment in Funders Club.) Not everyone with an idea and passion has connections to the angel investment community. Crowdfunding disrupts traditional market inefficiencies via automated platforms - and if the history of eBay can serve as precedent, the ripple effects may be significant.